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ALFRED
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WORKING PAPER
SLOAN SCHOOL OF MANAGEMENT
THE RENEWAL PROCESS AND OBSTACLES
TO INNOVATION
by
Zenon
S.
Zannetos
June 1983
MASSACHUSETTS
INSTITUTE OF TECHNOLOGY
50 MEMORIAL DRIVE
CAMBRIDGE, MASSACHUSETTS 02139
1445-83
THE RENEWAL PROCESS AND OBSTACLES
TO INNOVATION
by
Zenon
June 1983
S.
Zannetos
1445-83
Dr. Zenon S. Zannetos
Alfred P. Sloan School of Management
Professor of Management
Massachusetts Institute of Technology
THE RENEWAL PROCESS AND OBSTACLES
TO INNOVATION-
Introduction
I.
This paper is concerned with maturity of business organizations
and the process of renewal.
So the question comes to mind as to
whether maturity is inevitable, and whether the laws of human
physical maturity and eventual decline and extinction also apply to
business organizations.
We must ask ourselves: "Are we possibly
ascribing to business organizations attributes which apply to
ourselves, and thus constraining our creativity and the growth of our
organizations?"
If so, the maturity of business firms and industries
would be nothing more than an extension of our physiological
limitations and a self-confirming expectation.
II.
The Evolution of Firms and Industries
One of the greatest "inventions" in the history of mankind has
been the corporate form of business organization.
By use of this
arrangement, financial resources far in excess of what a
founder-entrepreneur and his/her family possess can be made available
to the firm, making possible the realization of economies of scale,
and the expansion of products as well as markets.
Far and beyond all
these benefits, however, the corporate form of business organization
has provided a medium for the perpetuation of the firm and the
creativity that drives it.
This separation of the life of the
* This paper draws partially on research suported by the U.S.
Department of Transportation and the Hyundai Corporation.
Assisting in the research were: Dr. Themis Papageorge and Messrs.
Ming-je Tang and William Lindsley
-2business entity from the frailties of the founders and their families
has paved the way for the phenomenal creativity and economic progress
of the last century and brought about the high standard of living
that all of us now enjoy.
Certain entrepreneurs and family-owned
firms realized succession for a while by bringing their heirs into
the organization, but some others were not as successful.
And it
does not take too much empirical research to convince one that the
"laws of evolution" are against the perpetutation of the family form
of business organization.
If, therefore, we accept the proposition
that a business entity is a living organism subject to the same
physiological limitations that govern the fate of human beings, the
questions arises as to why some organizations succeed in perpetuating
themselves and others do not?
It appears to me that the maturity of firms and industries, and
I
even dare say economies, is a relative phenomenon and that most
likely it is caused by constraints that we as managers, engineers and
scientists impose on our imagination.
Let us for a moment look at industrial history and draw some
No one can ignore available empirical evidence that, in the
lessons.
United States, we have firms and industries that have matured and are
declining.
friends,
I
So that
I
may not alienate people and make foes out of
will not mention specific firms by name, but instead
will concentrate on industries.
I
Shoes, textiles, ships, steel, farm
equipment, consumer electronics, automobiles, are but a few examples
of industries where the United States was preeminent and lost its
leading edge.
In this sense these industries,
matured and declined.
ill
the United States
Japan, on the other hand, found ample
,
-3-
opportunity for growth in almost all of these industries, while the
United States was languishing.
South Korea, Taiwan and Malaysia are now taking the leadership
away from Japan in some of the areas responsible for the Japanese
miracle.
Growth industries of a few years ago are now "sunset"
industries for Japan and orderly withdrawal from these markets is
being planned.
And this at the same time that those industries are
considered golden opportunities in some other far-eastern countries.
Looking now at firms within industries, be these mature or
growth, we find that some are growing at the expense of others.
It
would be a dull world, and one of uniform mediocrity, if every firm
was doing exactly as well or as badly as its competitors.
The lesson that we draw from all this, is that for every mature
industry there is at least one that grows; for every firm that
declines there is at least one that thrives on the declining firm's
miseries; for every challenged there a challenger; for every
conquered there is a conqueror; and for every obsolescence, in a
product, firm or industry, there is an innovative alternative that
caused the obsolescence.
In other words the phenomenon of maturity
and decline more often than not is causally related to the emergence
and growth of a substitute product, firm or industry.
So what is it
that drives certain organizations to success while others are failing?
We have heard recently a lot of arguments regarding the causes
of the decline in U.S. industrial productivity and the most popular
view is that the culprit is lack of capital formation and capital
investment.
While we may accept that we do not invest enough, it is
not clear which is the cause and which the result.
Are firms
investing because they have innovative ideas and available
-4-
opoortunities for growth, or are the opportunities available to them
because they invest?
If the latter were true, then the more money a
firm spends the more innovative ideas it would have.
Well, the world
is not that simple and we will do ourselves and our organizations a
great disservice if we do not try to understand: "What is the cause
and what the effect?"
At least in the case of the U.S. automobile industry, the
evidence does not support the hypothesis that the problems were
caused by lack of investment.
It is more likely that the culprit
is lack of product innovation.
The effective value per dollar of
expenditure, by the average buyer, of a Japanese car appears to be
far greater than that of an American car.
That is one reason why
imitation of the Japanese automobile manufacturing technology will
not bring about any relief to the U.S. automobile industry.
as I pointed out elsewhere
2
,
In fact,
if all other things (such as product
characteristics) are equal, exact imitation of a process technology
which is optimal in one country is not necessarily so in another.
And this, because the relative cost of the factors of production is
most likely different.
We all know that the cost of capital and
labor is different in Japan from that in the United States.
Unless
therefore, the Japanese process technology is adapted to reflect the
domestic input costs, the U.S. automobile firms which imitate it will
put themselves at a permanent cost disadvantage.
So, the key appears to be value generating product innovation.
III.
Organisms, Organizations, Data and Information
Before we proceed to analyze the impediments to innovation and
change, it is necessary to distinguish between an organism and an
organization and between data and information.
From a cybernetic viewpoint, an organism is not an
-5-
organization.
3
An organization is goal seeking, has a purpose, and
can sustain itself without depending upon continuous input of
information from the outside.
An organism, on the other hand,
depends on continuous input from the outside, without which it cannot
function let alone change its structure in times of crisis.
Organizations can be composites of goal-seeking organisms as long as
the latter are self-organizing, and can survive by generating
internally the information necessary to sustain themselves.
Thus, in
devising strategies for change and growth, organization structures
and information systems are key ingedients to success.
Since information is so vital to the survival, restructuring
and growth of organizations, it may be advisable to distinguish
between data and information.
Data are the output of objective models such as the accounting
system, and are universally accepted, because the majority of
"experts" say so.
Information on the other hand, is the meaning or
intelligence that is derived when the date are put in an appropriate
(associative) context.
The associative contect is subjective and the
more unique it is, the greater the potential comparative advantage it
provides to those who possess it.
Models enable us to create some of the associative contexts
which are necessary for sustenance, renewal and growth.
Models are
nothing more than abstract representations of the world we want to
deal with and in the way we see it.
Obviously, the greater the
degree of detail the models provide, the greater the content and the
more limited the meaning they impart.
Also the more universal their
acceptance in managerial decision making the more objective the
models become, and the lower their potential for providing a
-6comparative advantage to the firm.
In the business world, sustenance and renewal can occur
through innovation.
Some firms obviously will do better in their
efforts than others, although each one of them would like to be on
the side of the spectrum where it does better than the average
competitor.
The only way this can be done is through better
knowledge, powerful associative contexts, and more effective
strategic management of resources.
The latter, as I shall soon
stress, involves a dynamic balance between specialization, and the
concomitant aversion to change, and change itself.
IV.
Obstacles to Innovation
Although we do not know exactly how innovation occurs, we see
ample evidence that innovative talents exist widely and are not the
monopoly of any one firm or industry.
The specialization of
individuals and firms, however, as well as the environment within
which the work is carried out influence the associative context of
individuals and the effective utilization of their creative talents.
Many times we hear of people who leave their employment either
because they feel that their creativity is being stifled within their
organization or because they cannot convince their superiors of the
value of their new product ideas.
The history of the semi-conductor,
electronics and computer industries is replete of examples of "spin
offs" both successful and unsuccessful.
A^study, therefore, of the
obstacles to innovation and the process of renewal is very
instructive and for this reason we will concentrate on the
impediments, after we say a few words about innovation itself, and
its objectives.
A. Types of Innovation
There are two major types of innovation, product and process.
-71.
Product innovation addresses itself to those aspects of
technology that create value to the product in use.
In the final
analysis it is the market place that decides as to whether a product
innovation is successful or not, either because the functional
characteristics of the new product are such as to merit a value which
is greater than its relative selling price (inflated by the relevant
switching costs) or because the new product has unique and completely
novel characteristics whose value is assessed by the users as being
greater than the cost to them of the new product.
In the process of developing a new product the firm may develop
a core technology that applies to one product or to a family of
products.
Obviously the latter is more beneficial, if successful,
because it can sustain the firm longer and enable it to make larger
and more cost-effective investments in process innovation.
2.
Process innovation is concerned with the technology the
firm uses to produce its products and services.
The aim is
efficiency through specialization and is usually obtained by means of
heavy investment of time and capital.
The net effect is a reduction
of the manufacturing cost of the product.
There is invariably a basic conflict in process innovation in
that specialization is achieved at the expense of flexibility and
independence.
Heavy investment of time and money normally creates
"fixities" and huge facilities which cause technical and
technological interdependences among the products and services using
the facilities, at any moment in time and over the economic life- time
of the facilities.
So a miscalculation on the high side may result
in a lower product cost at the beginning, but may inhibit the
adoption of new process technology later on when it becomes
-8-
available.
Also it may, as
to an obsolete product.
I
will soon argue, get the firm locked in
Underinvestment, on the other hand, may
affect the initial profitability of the firm and erode some of its
competitive advantage.
A synchronization of the product life cycle and that of the
process technology is imperative.
Unfortunately, within many firms
these two classes of decision, product and process innovation, are
usually made independently and serially.
In fact,
manufacturing-process decisions are often made as if the products
have infinite life.
One can readily conclude that the strategy of
obsoleting one's product must dictate the nature and extent of
manufacturing technology.
The greater the uncertainty or turbulence
impinging on the product, the greater the "labor" intensity of the
product, because the economic environment does not encourage large
investments in new manufacturing processes which will last,
physically, for long periods of time but may soon become obsolete.
Critical proprietary aspects of process technology may be
either found in the "head" of those using the technology or may be
captured in instrumentation.
There are several advantages to storing
process technology in instrumentation expecially if it is complex.
First of all, employees cannot easily pirate the technology of a firm
and start up a business to compete with their previous employer.
Then, one has the problems of bondage to certain employees and of
consistency of quality, if uniformity in the application of
technology is not possible.
Finally, process instrumentation may
become a product to be either sold or licensed.
Licensing or selling
process technology may be one of the best ways of locking in others
to one's own technology and at the same time raising the cost
-9-
function of competitors, a comparative advantage not many firms
exploit.
Of course, one may say that the best comparative advantage
is to keep technology secrets from competitors.
If that can be done,
fine; but more often than not competitors not only imitate enough to
effectively compete but also improve on the innovation, rendering the
originator obsolete.
B.
Objectives of Innovation
The principal objective of innovation is the creation of a
comparative advantage which enables the innovator to extract an
economic monopoly rent.
In other words, if a firm has an unique
product or process which adds value to the user per dollar of cost,
far in excess of what competitive products and processes do, the
innovator should be able to get a higher price than the competitors.
In the case of product innovation, the product is
differentiated and therefore not subject to price competition.
At
the same time it may be positioned in a niche which makes it
insensitive even more so to price competition because the demand
facing firms in such situations is very inelastic .
Capitalizing on
its technology and the characteristics of its product, the firm may
erect barriers to entry for others and further insulate itself.
Similarly process innovation allows the firm to enjoy absolute
cost advantages
,
to block the entry of others ususally through
patents and low prices, and to increase in general the cost of entry
of potential competitors.
Because product innovation addresses itself to the value in use
and the demand of the product, its benefits normally last longer than
those of process innovation.
The comparative advantage gained
through product innovation, in other words, is normally greater than
that of process innovation unless the latter results in a product.
-10C. Types of Obstacles to
Innovation
Our work at the M.I.T. Sloan School of Management
identified three major obstacles to innovation.
4
These are
associated, one each, with fixed investment, management, and labor,
ands we refer to them as "critical fixities."
The investment fixity is caused by the heavy capital
requirements that are normally associated with manaufacturing
processes.
We all know that economies of scale are mostly obtained
through the specialization of resources, the major one of which is
capital.
Large amounts are invested in plant, machinery and
equipment resulting in the loss of flexibility, as well as
divisibility, and relating the cost of products and services over the
life-time of the investment.
Most often the larger the fixed investment, other things equal,
the lower the long-run average cost of the product.
Also, the
greater the cost fixity the lower the marginal cost (out-of-pocket or
incremental cost) of using the facility for its orginally intended
(designed) purposes.
For example, large refineries, steel mills,
utilities and assembly plants enjoy, at full capacity, a lower
long-run average cost than their smaller counterparts.
This lower
cost is gained at the expense of flexibility and divisibility.
Taking now the short-run, the larger the facility and the more
automated, the smaller is the out-of-pocket cost component of the
total cost of the products produced.
The same can be said about the
incremental costs associated with the changes in volume and of
operating versus shutting down the facilities.
It is a fundamental economic dictum that unless the long-run
average full cost of a new facility or a new product (given same
-11value) is less than the out-of-pocket cost (marginal) of the old, no
manager should make the investment.
Incidentally, the cost of the
challenger must also include all the necessary retraining and other
switching costs.
So, the greater the investment fixity, and as a
result the lower the marginal cost, the more formidable are the
economic obstacles to innovation and change.
It is an irony that the greater the investment miscalculation,
induced by the desire to lower the long-run cost of the product, the
lower normally is the marginal cost and the greater the aversion to
change.
So the greater the white elephant, the longer one tends to
stay with it, for good economic reasons.
The second type of fixity is associated with management, and it
also has its roots in specialization.
The more we specialize, the
more we gain in depth at the expense of breadth, and the more
inflexible we become.
Therefore, both the economic as well as the
psychic costs are less in continuing on existing paths.
This means
that the switching cost and the fear of change become greater and
greater as one specializes more and more.
Another consequence of specialization in depth and the loss of
breadth relates to the associative context.
limited to our speciality.
It becomes more and more
As ^ result, innovative ideas outside the
area of our specialization are not likely to be generated or allowed
to flourish.
We are all familiar with the N.I.H. factor and the
power of statements such as, "that's not the way things are done
here."
The managerial fixity then affects innovation and change in two
ways.
First of all the switching costs and the fear of obsolescence
may be so great as to create a barrier to change and, second, the
innovative ideas may not be forthcoming from within nor will they
-124
have much of any chance of success if brought from the outside.
Finally, the organization has to contend with the labor
fixity.
As in the case of the investment and managerial fixities,
specialization is a two-edged sword.
While it enables us to achieve
economies, specialization of workers by function creates an aversion
to change and serves as an impediment to innovation.
It is very
painful and difficult to successfully retrain people and switch them
from one function to another, if they have for years concentrated on
a very narrow specialty.
The threat of obsolescence, the loss of
comparative advantage and the psychic as well as the economic costs
of switching and "starting all over again" make people fight change
and impede the adoption of innovation.
From some cursory evidence that we have thus far, it appears
that the probability of completing the retraining program is lower
the longer a worker has been on the job.
What is more, and even if a
worker completes the retraining program, the probability of
effectively applying the knowledge gained to the new activity appears
to be minimal.
The switching costs, both economic and psychic, and the
narrowness of the associative context, once again, become very
formidable barriers to innovation and change.
To summarize, we have three critical fixities
managerial and labor
—which
— investment,
serve as obstacles to innovation.
Managers by strategic design, must strike a balance between
specialization and breadth, and determine as well as synchronize the
life-cycles of the critical fixities.
And this so that the
organization is not plagued by dominant fixities that inhibit the
innovative tendencies of the organization.
-13V.
The Management of Complexity
Change induces complexity and many of us are afraid to deal
with it.
We must remember, however, that if we do not do anything
about it, someone else will and may drive us out of business.
If our
competitors be they domestic or foreign can innovate, why can't we do
so by plan rather than crisis?
Why should we allow our competitors
to decide the life-cycle stage of our organization?
Complexity is managed by applying to it appropriate
And as we have already mentioned information is
information.
generated, perceived and conceived when data are placed in an
appropriate associative context.
The latter notion is very simple
but at the same time extremely complex.
It is an abstract notion
with various (infinite) levels of abstraction for any given
situation.
Consciously or unconsciously managers use it everyday as
they obtain signals from operations and attempt to derive meaning out
of data.
At the risk of oversimplification,
I
will try to illustrate the
dependence of information on the associative context, by drawing on
some of the results of our work on productivity and innovation at the
M.I.T. Sloan School of Management.
Exhibits
I
and II present the traditional measurements of
progress based on the accounting model of the firm.
Using this
context, one can derive information and arrive at the conclusion that
G.M. has been progressing and increasing its productivity steadily
since 1958, with the exception of 1970 when they had a strike, and
1974 and 1975 because of the "oil crisis."
While profits were going up, however, the share of imported
cars increased by a factor of five in sixteen
-14The loss of market share provides information that G.M. and
years.
the U.S. auto industry were losing their comparative advantage and
their monopoly rent, which is in conflict with the information
provided by accounting short-term profitability.
If a firm or an industry effectively innovate s, it derives a
monopoly rent, which means that it can pass on to the customers all
its cost increases and more.
Effective product innovation allows one
to do that because the value generated is far greater than the costs
of obtaining it.
Process innovation, on the other hand, aims at cost
reduction leaving the value unaffected.
If, therefore, a firm or an
industry experiences cost increases per unit of product, it means (by
definition) that it did not succeed in offsetting these by process
innovation.
Exhibit IV indicates that G.M. lost its monopoly rent.
It
simply could not pass on to its customers the cost increases of the
producers of the goods the automotive industry was using.
On top of
all this, of course, salaries, wages and benefits were increasing at
a much faster pace thanboth new car prices and producer goods
prices.
.
To enrich our associative context even more and derive better
information about productivity through innovation at G.M., let us
look at economic value added per dollar of payroll and benefits.
Exhibit V Indicates that since 1962 G.M. has been steadily losing its
monopoly rent because product innovation was not adding enough value
to offset the cost increases.
So if the data were put in the value-added context, rather than
the traditional accounting associative context, the meaning would
have been different.
The declining trend in productivity would have
been foreseen in the mid-sixties.
information until the early 80
's.
Profits did not reveal any crisis
-15In conclusion, product innovation is the key to increases in
productivity and growth.
Maturity and decline are not inevitable,
unless you as managers abdicate your responsibilities for bringing
about change.
As managers you will have to manage technology, introduce
change as part of your strategy and must, therefore, have a strategy
for managing technological change.
Planned introduction of new products and the obsolescence of
old by design, is a must, and so is the synchronization of product
and process life cycles.
Human resource development must be treated as a strategic
issue, and managed to enrich the associative-context capabilities of
managers.
This will minimize their fixity and switching cost; will
enable them to effectively manage human and capital resources and
protect your organization from the investment and labor fixities with
all their detrimental consequences on innovation and change.
,
-16-
References
Lindsley, W., Papageorgiou, T., Tang, M.,
"Productivity Measurement: Applications to the Automobile
Industry," SSM Working Paper 1234-82 .
1.. Zannetos,
Z.,
Papageorgiou, T., Tang, M., "An
Zannetos, Z. Lindsley, W.
Analysis of the Dimensions of Productivity of the U.S.
Automobile Industry and Some Explanations," SSM Working Paper
1274-82 .
,
2.
,
Zannetos, Z., "The Management Process, Management Information and
Control Systems, and Cybernetics" (with Jarrod W. Wilcox), SSM
Working Paper 412-69 . Chapter in Proceedings of International
Congress of Cybernetics London 1969, Chapter in Process of
Cybernetics Vol. 2, Ed. by J. Rose, Groden and Breach Science
Publishers, London 1970, pp. 685-701.
,
,
Forthcoming in
3.
Zannetos, Z., "Strategies for Productivity,"
Interfaces .
4.
"Innovation
Papageorgiou, Tang, M.
Lindsley, W.
Zannetos, Z.
and Critical Fixities," SSM Working Paper l343-82.5.
5.
Lindsley, W., Papageorgiou, T., Tang, M.
Zannetos, Z. ,
"Productivity Measurement: Applications to the Automobile
SSM Working Paper 1234-82 .
Industry,"
,
,
,
Zannetos, Z. , "Growth, Productivity and Its Measurement," SSM
Working Paper 1431-83.
+
Exhibit
I
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1600.
%
*
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+
54.0
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60.0
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+
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NET INCOME
72.0
(CM)
+
78.0
YEAR
84.0
J-
Exhibit II
14.51
12.0;
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EARNINGS PER SHARE IGM)
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72.0
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70.0
YEAR
84.0
1-
Exhibit III
US
24 . 0+
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20.0+
16.0+
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8.0 +
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IMPORTED CARS MARKET SHARE
+
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Exhibit IV
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1.100*
g $
1.050+
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NEW CAR PRICE INDEX OVER PRODUCER PRICE INDEX (AUTOMOBILE INDUSTRY)
Exhibit V
VA/PAYG
2.05+
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VALUE ADDED OVER PAYROLL AND EEMEFITS
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